Analysis of policies for managing public sector wage bills in the Middle East and Central Asia region. While some work has been done recently at the Fund on issues related to government employment and compensation, to our knowledge, this is the first study to systematically examine, with a focus on the Middle East and Central Asia region, the recent trends and drivers of public wage bills in the region and to identify key policy implications.

Policy Objectives

Employment

In many areas of the MENAP region, high wage bills reflect the traditional role of the state as the employer of first resort. Since the 1960s, some MENAP governments have provided jobs in exchange for the population’s political support, to reduce unemployment and foster social cohesion.1 A privileged civil service has evolved amid deep-rooted impediments to private sector development (Hertog 2017; World Bank 2009), incentivizing a strong preference of job seekers toward government employment (Gatti and others 2013: 51). In the wake of the Arab Spring (Amin and others 2012), real wage bill growth accelerated in most MENAP oil importers, reflecting wage hikes and/or increased hiring. In Tunisia, for example, annual government hiring significantly increased during 2011–12 as former contractors and informally employed workers were brought into formal public employment (Brockmeyer, Khatrouch, and Raballand 2015; Annex 2). Several MENAP oil exporters indirectly affected by the Arab Spring have also increased public employment (Algeria, Bahrain, Qatar).

The diminished role of the state in the CCA stands in contrast to that in the MENAP region. Following the breakup of the Soviet Union, public sectors have downsized with privatization and, in some cases, civil service reforms (Georgia) (IMF 2014b; case study on the Kyrgyz Republic in Annex 2). Hyperinflation eroded real public wages and pensions in the early 1990s. Public sector employment has lost much of its attractiveness—although it remains higher than in comparable countries—while public wage growth has lagged that in the private sector.

Oil Wealth Distribution

Public payrolls in the GCC have been used to distribute oil income. The region is home to the highest concentration of oil wealth in the world, and countries with higher oil income per capita generally have high public wage bills in per capita terms (Figures 3.1 and 3.2). This is associated with high public-private sector wage gaps and extensive public employment of nationals in the GCC, while their private sectors rely primarily on expatriate labor.2

Figure 3.1.Average Net Fuel Exports per Capita, 2007–16

Source: World Bank, World Development Indicators.

Note: Countries with net fuel exports of over 2 percent of GDP. Data labels in this figure use International Organization for Standardization (ISO) country codes. MCA = Middle East and Central Asia.

Figure 3.2.Wage Bills and Fuel Exports in the Region, 2005–15

Sources: IMF, World Economic Outlook; and World Bank, World Development Indicators.

Note: Data labels in this figure use International Organization for Standardization (ISO) country codes.

Oil income distribution through public wage bills is less apparent in other oil exporters. In non-GCC MENA and CCA oil exporters, oil revenues and public wage bills per capita are significantly lower than those in the GCC (Figures 3.1 and 3.2). Wages of nationals and expatriates are more similar in these regions, and average government wages are more closely aligned with average private sector wages. Nonetheless, public employment is high, accounting for 25 percent of total employment in the CCA and nearly 40 percent in Algeria and Iraq. Public employment is lower in Iran and Yemen.

Economic Factors

Fiscal Revenues

Availability of fiscal revenues is a key determinant of public wage bills over the long term (Figure 3.3).3 An additional percentage point of GDP in the average long-term level of revenue is associated with an addition of 0.26 percentage point of GDP to the wage bill in a sample of 160 countries. The elasticity for the Middle East and Central Asia is similar.4 Oil prices are an important driver of fiscal revenues in the region’s oil exporters and, via their impact on remittances, of revenues in oil importers (Box 2).

Figure 3.3.Public Wage Bills and Fiscal Revenue, 2007–15

Sources: IMF, World Economic Outlook; and World Bank, World Development Indicator databases.

Temporary relaxation of fiscal constraints triggers increases in wage bills, especially in the region’s oil importers.5 A one percentage point increase in real revenue growth, on average, is associated with a 0.24 percentage point increase in real wage bill growth a year later in oil importers—a much higher increase than the emerging market and developing economy average (0.05 percentage point).6 The elasticity in the region’s oil exporters is 0.08 percentage point, similar to that in other fuel exporters around the world.

Demographics

Young demographics in most MENAP and CCA countries create high demand for education services. The region’s population is among the youngest in the world, with over 40 percent under 20 years old (Figure 3.4). Not surprisingly, public education therefore accounts for a significantly higher share of spending and employment than in global peers (Figure 3.5). For example, government expenditure on education in the Kyrgyz Republic, Morocco, Saudi Arabia, and Tunisia is 1–2 percentage points of GDP higher than the emerging market and developing economy average of 4 percent of GDP. In the Kyrgyz Republic and Tunisia, the combined wage payments in health and education account for more than half of the total government payroll (Figures 3.6 and 3.7).

Figure 3.4.Share of Population under 20, 2015

Source: United Nations’ Population Division.

Figure 3.5.Public Employment in Health and Education Sectors

Sources: Country authorities; national labor surveys; and the International Labour Organization.

Figure 3.6.Wage Bills and Public Expenditure on Health, 2007–14

Sources: IMF, World Economic Outlook; and World Bank, World Development Indicators databases.

Young demographics also imply large numbers of new job market entrants. Youth unemployment, especially in MENAP countries, exceeds that in most comparators (Figures 3.8 and 3.9). Indicative of the lack of dynamism in the private sector, youth unemployment in many countries has increased since 2000. These challenges have reinforced the demand for public employment and incentives to maintain social cohesion through government hiring.

Geopolitical Tensions

High incidence of conflicts and terrorism require large security-related payrolls (Rother and others 2016). Often not reported by governments, security-related payrolls are likely to be high in many parts of MENAP. In Afghanistan and Iraq, two countries where such data are available, security-related expenses account for nearly 70 and 40 percent, respectively, of the total government wage bill.

Spillovers from conflicts, such as increased inflows of refugees and internally displaced people also put pressure on public services and wage bills. In Lebanon and Jordan, refugees from Syria and Iraq account for one-quarter and one-tenth of the population, respectively. Similarly, Pakistan hosts many internally displaced people and close to 2 million refugees (1 percent of the population) from Afghanistan. Afghanistan had to accommodate many returning refugees and internally displaced people fleeing violence. These spillovers have augmented pressures on wage bills through increased demand for public infrastructure and basic services.

Institutions

Weak institutions and governance have contributed to the swelling of public wage bills in the region and have complicated their management and control. Political pressures and entrenched corruption have also been a challenge in some countries. As in the rest of the world, wage hikes and employment are often significantly affected by political factors (Borjas 1984; Matschke 2003; Dahlberg and Mork 2011).7 Many countries allow political appointments (Georgia, Kyrgyz Republic, Lebanon, Pakistan, Tajikistan) or decentralized hiring (Bahrain, Jordan, Mauritania, United Arab Emirates), which may enhance the role of politics in hiring. In some economies (Qatar, Saudi Arabia, Tunisia, West Bank and Gaza, Yemen), civil service commissions make hiring decisions, but they may not be free from political influence.

Governments in the region often do not know the true size of and have limited control over public employment and compensation. In many countries, comprehensive employee accounting and tracking systems are absent, public hiring is subject to few controls, and public sectors often employ “ghost” and informal workers (that is, those not on official payrolls or without formal employment contracts). In addition, public compensation policies are rarely well defined or are not linked to performance. Discretionary wage setting is prevalent. In many countries, elaborate systems of allowances—often exceeding base salaries—limit governments’ control over wage bills.

Alesina, Danninger, and Rostagno (1999) argue that in most MENAP and CCA countries, public employment, directly or through state-owned enterprises, has been aimed at offsetting persistently high unemployment.

So far, only a few studies have examined the impact of public wage bill spending on government revenue, expenditure, and overall balance. Kraay and Van Rijckeghem (1995) find a positive relationship between government employment and the easing of resource constraints in both Organisation for Economic Co-operation and Development (OECD) and developing economies. Eckardt and Mills (2014) and Cahuc and Carcillo (2012) suggest that the effect of wage bill expansions on the overall balance is negative and statistically significant for a broad set of countries.

There is no strong evidence to suggest that wage bills vary significantly over the business cycle in the region, possibly reflecting measurement issues in estimating output gaps or a limited role of wage bills in aggregate demand management. In a global sample, IMF (2016a) estimates that, on average, real wage bill spending grows by 0.22 pp more as the output gap widens by 1 pp. Public wage bills in that study were found to be more procyclical in advanced economies which is consistent with studies by Lamo, Pérez, and Schuknecht (2007) and Eckardt and Mills (2014). Cahuc and Carcillo (2012), using an OECD sample, find a strong positive correlation between the public wage bill and fiscal deficits.

These estimates are based on a fixed-effects panel regression of real public wage bill growth on lagged real fiscal revenue growth annual data from 1992 to 2016. Data availability varies by country. The quoted regional elasticities are statistically significant at the 1 percent significance level, whereas emerging market and developing economy elasticity was significant at the 5 percent level.

IMF 2016a estimates that the wage bill is 0.53 percentage points higher during an election year than a non-election year. The impact of elections is larger in emerging markets and low-income and developing countries compared than in advanced economies, most likely due to stronger fiscal institutions in advanced economies.